CAATSA and the Russian pipelines: how hard the bill can hit them?

The Author

Madalina Sisu Vicari is a PhD candidate at the University of Liège. Her main research interests are: the geopolitics of energy, energy security, Ukraine’s and Turkey’s energy cooperation with EU, EU-Russia energy relations, EU’s external energy governance, European regionalization. She holds a Master’s degree in International Relations and a Master’s degree in Communications and European Affairs.

The Countering America’s Adversaries Through Sanctions Act (CAATSA) bill, passed by the U.S. Congress with full bi-partisan support, and enacted on August 2, 2017, sparked stormy reactions of some EU Member States- notably Germany and Austria-, brought hopes for those opponents of Nord Stream 2 pipeline who had expected for the project to be sanctioned by the United States, and generated a wide range of opinions over the application of sanctions mechanism.

This paper aims to examine how and to which extent the provisions of the bill may affect the Russian energy pipelines, especially the Nord Stream 2 and Turkish Stream pipelines.

1. Sanctions on Russia until CAATSA -smart sanctions coordinated with the Europeans

The sanctions imposed on Russia (through different Executive Orders and Congressional legislation, including CAATSA) by the United States since 2014 are targeted sanctions. Though expanded and tightened on various rounds since their imposition, they particularly target Russian individuals and entities operating in specific and critical sectors (finance, energy, defence) and exclude comprehensive trade embargoes.

The idea of targeted or “smart” sanctions was inspired by the effects of the United Nations sanctions imposed on Iraq in early 1990s, considered by many experts as the most comprehensive trade embargo in history, and which bore high economic and humanitarian costs for country’s population without succeeding to determine the Iraqi regime to change its policy.

Furthermore, not only the Iraqi regime manoeuvred to strengthen its position but the sanctions triggered additional political problems: the regime put the blame for the humanitarian disaster on the United States and the United Nations, and the corruption spread, as the UN Oil for Food scandal showed it. Therefore, “the political and humanitarian disaster of the Iraq sanctions episode led policy-makers to search for innovations in the implementations of economic statecraft (…) Smart sanctions were the resulting alchemy between the scholarly and policy-making communities”.

Multiple researches conducted on comprehensive sanctions came to the general conclusion that they generate counterproductive effects: their economic effects widely affect the lower and middle classes whereas they enhance benefits and rent-seeking opportunities for the proponents of the targeted governments, which frequently use the sanctions as a pretext to strengthen the control over population and heighten the repression.

Consequently, the targeted sanctions were designed as a “more humane policy tool”, which would avoid extreme humanitarian costs and, potentially, further repression in authoritarian countries. The effectiveness of targeted sanctions is highly dependent on the targeted sector: for instance, financial sanctions hit harder than trade sanctions and oil embargoes affect the economy more significantly than arms embargoes.

Nevertheless, evidence resulted from many studies-though further work on the long-term effects is still needed-suggests that potentially smart sanctions do not trigger significant policy changes from target state. The smart sanctions “clearly solve the political problem of ‘doing something’ in the face of target state transgressions”. Yet, Drezner argues, the sanctions “do not solve the policy problem of coercing the target state into changing its policies”.

Coercion, along with constraint and signalling are the purposes of smart sanctions. However, according to Hastedt, for coercion to happen, the goals of the behaviour change targeted by sanctions should be narrowly defined. The sanctions whose purpose is to constrain its targets (regimes and organizations) to engage in certain behaviours or to limit their behaviour and/or power are more likely to be successful.

The signalling sanctions aim to flag those countries that transgress the international norms and standards, and target key leaders and their families through different measures, which range from travel bans to commodity sanctions. As it seems highly unlikely that the Russian regime would significantly alter its behaviour and policies due to sanctions’ effects, one can assume that the sanctions’ purposes imposed by the United States are constraint and signalling.

Until the adoption of CAATSA, all the stages of sanctions against Russia (travel restrictions and asset freezes for selected individuals; import ban on goods originating from Crimea or Sevastopol; followed by measures to restrict Russian entities access to capital and financial markets; embargo on the imports and exports of arms and related material; trade prohibition of goods, services and technology destined for exploration or production of deep water oil, Arctic oil and shale oil projects in Russia) were characterized by regular coordination between the United States and the European Union, despite that “sanctioning a target the size and might of Russia” was not only a challenge but also a source of frictions between the two allies, and the economic costs incurred have been considerably larger for the EU than for the U.S.

Conversely, the U.S.-Russia trade interdependence is minimal( in 2013, the total trade volume in goods between the two countries was USD 38 billion, which ranked Russia as the 22nd trade partner for the United States). Consequently, the economic costs of sanctions against Russia were substantially lesser for the United States’ economy than for the EU’s.

Claiming that the bill aims to favour the selling of U.S. LNG and to halt the supply of Russian gas in the European market, the two politicians brings into the debate the trans-Atlantic relations, which, they allege, are negatively affected by the threat of imposing penalties on European companies participating in natural gas projects involving Russia, such as Nord Stream 2. No fewer than four exclamation points are included in the document, which, though issued only by two EU Member States, bountifully refers to “Europe”:

“We cannot, however, accept the threat of illegal extraterritorial sanctions being imposed on European companies that are participating in efforts to expand Europe’s energy supply network! (…) Europe’s energy supply network is Europe’s affair, not that of the United States of America! (…)Foreign policy interests must in no way be linked to economic interests! There is still enough time, and opportunity, to prevent this! “

The contiguous discursive articulation around “Europe” and specifically the possibility of Commission’s retaliation were included in the German officials’ further reaction to the bill: “The Americans can’t punish German companies because they have business interests in another country (…) Of course, we don’t want a trade war. But it is important the European Commission now looks into countermeasures”, Germany’s minister of economy, Brigitte Zypries, declared.

Though it appears that Germany suffered, due to the sanctions, the biggest nominal loss in terms of exports of EU 28, its opposition to those bill’s provisions that might affect the Nord Stream 2 project is mainly rooted elsewhere than sanctions’ effect on Berlin-Moscow bilateral trade. Actually, the country’s opposition to CAATSA’s provisions related to Russian energy export pipelines can be widely explained by the material path dependencies established by the German-Russian rapprochement occurred after the post-Cold War era, which limits Germany’s capacity to put “coercive pressure on Russia”. Dyson argues that, during sanctions negotiations in 2014, of the major Western European members, “Germany has been most active in attempting to limit EU sanctions against Russia’s energy sector.

According to Szabo, Germany “is pursuing the grand strategy of a geo-economic power”, which sees “its power as defined by prosperity and success in the growing competition of global economic market place”. Consequently, the politicians are valued not by their military successes, but by their performances in the economic sphere.

The economic interests, however, play a significant role in defining Berlin’s security interests, Szabo argues, and that is why access to raw materials, principally energy and minerals, and relationships with those states that supply natural resources are a priority for a geo-economic power as Germany. That offers a generic explanation of Germany’s aforementioned attitude that aimed to limit the EU sanctions against Russia’s energy sector on one hand, and of its opposition to CAATSA, on the other.

Dyson proposes a more specific explanation, within the geo-economic paradigm, which consists of two items: “the desire of German energy industry to protect its privileged relationship with Gazprom and the unwillingness of German politicians to deal with the political implications of the increased cost to consumers associated with reducing dependence on Russian gas”.

Furthermore, Russian gas exports to Europe (and Turkey) reached all-time record in 2017 and an important share of them was transported via the Nord Stream 1 pipeline- 51 bcm, which means that the pipeline operated at 93 % of its 55 bcm annual capacity (deliveries increased since August 2017, following a ruling of the EU’s General Court that lifted a suspension enabling Gazprom to book spare capacity in OPAL pipeline; however, the Court’s final decision is expected in 2019).

Some scholars argue, as presented above, that within Germany-Russia energy relation, the gas supply security dimension: i) is shaped up by Berlin’s need to ensure access to raw materials (Szabo); ii) has failed to be appropriately recognized due to dominance, in Germany, of the environmental lobby, and the dominance, within the executive, of civilian power approaches, which emphasized too much the potential of “Wandel durch Verflechtung“ (“Change through integration”) policy (Dyson).

However, when assessing the gas supply security dimension within the German-Russian energy relation, what should be principally taken into account is the sensitivity interdependence between the two countries. The interdependence in the energy sphere between Germany and Russia involves sensitivity, as i) changes in one country’s policies (i.e.: sharp reduction of Russian gas imports for Germany; or conversely, a significant decrease of its exports to German market for Russia) would bring costly changes in another; ii) the framework of policies wherein the interactions (the energy sphere) take place between the two countries is likely to remain unchanged on short and medium term at least.

The interdependence between Germany and Russia in the energy sphere is also enhanced by other dimensions than that of gas supplies, which, nevertheless, remains the most important. A fundamental dimension of the sensitivity interdependence between Berlin and Moscow in the energy sphere pertains to the German-Russian joint ventures “created along the whole value chain”, which involve joint projects on “gas extraction, transport, sales, processing, deposits and storage”; i.e.: joint ventures such as WIEH, WIEE, Wingas, are the result of cooperation between the BASF, a major player on the German market, and Gazprom; following an asset swap deal, Wintershall (a subsidiary of BASF) transferred to Gazprom its share in the above mentioned companies including shares in astora company.

In this context, it is worth mentioning that while Gazprom got access to mid- and downstream sector in Germany, the German energy companies, especially through asset swaps deals, received access to the Russian upstream sector, in exploration and production projects. For instance, the German companies Wintershall and Production GmbH (belonging to E.ON) are, together with Gazprom (holders of most shares), shareholders of OJSC Severneftegazprom, which operates one of the largest gas fields in the world, Yuzhno-Russkoye.

Large joint infrastructure projects are another important dimension but also an outcome of the German-Russian sensitivity interdependence. Hence, Wintershall is a shareholder, respectively financial investor of Gazprom’s flagship-and widely criticized by some Member States- pipeline projects, Nord Stream 1, respectively Nord Stream 2. Furthermore, E.ON, through its subsidiary, PEG Infrastruktur is a shareholder of Nord Stream 1 pipeline project whereas Uniper (a former E.ON subsidiary) is one of financial investors of Nord Stream 2.

As indicated by Westphal, Bros and Mitrova, Gazprom has a large presence into the German gas market, as it managed to expand along the whole value chain of mid- and downstream segment: transporting, trading, marketing, storage. Germany has the largest gas storage capacities in the EU and the fourth-largest gas capacities in the world and Gazprom’s new positioning into Germany’s storage system, especially after the takeover of astora company (one of the largest operators of gas facilities in Europe), enhances the Russian company’s position on the market and its ability to play with large volumes.

As for potential sanctions, the U.S. President can choose from a list that includes : 1) export-import bank assistance for exports to sanctioned persons; 2) export sanctions for any goods or technology); 3) loans from the U.S financial institutions.; 4) loans from international financial institutions; 5) prohibitions on financial institutions; 6) procurement sanctions (on any goods or services); 7) foreign exchange; 8) banking transactions; 9) property transactions; 10) ban on investment in equity or debts of a sanctioned person; 11) exclusion of corporate officers; and 12) sanctions on principal executive officers.

Which pipelines might be affected by CAATSA’s provisions? Before answering to this question, it should be mentioned that after the U.S. House of Representatives passed the vote on CAATSA, on July 25, 2017, and before the vote of Senate, the European Commission’s services had prepared, for the College of Commissioners’ assessment, a list of projects involving European companies and that were considered to be affected by the sanctions.

In this respect, the State Department’s guidance brings some necessary clarifications related to the sanctions targeting the energy export pipelines. Firstly, it indicates which pipelines can be sanctioned: those “that (1) originate in the Russian Federation, and (2) transport hydrocarbons across an international land or maritime border for delivery to another country”.

Secondly, the guidance establishes that the sanctions would target: (1) “investment that meets the fair market value thresholds in Section 232(a) and directly and significantly enhances the ability of the Russian Federation to construct energy export pipeline projects initiated on or after August 2, 2017, or (2) sells, leases, or provides to the Russian Federation goods or services that meet the fair market value thresholds in Section 232(a) and that directly and significantly facilitate the expansion, construction, or modernization of such energy export pipelines by the Russian Federation”.

Furthermore, sanctions would not target investments or activities related to the standard repair and maintenance of pipelines in existence as of August 2, 2017.

Put it differently, implementation of sanctions would focus on: (1) investments (including those in repair and maintenance) in pipeline projects initiated starting August 2, 2017, and which exceed $1 million or more (or $5 million or more during an year-period); (2) sells, leases, or goods or services provided starting August 2, 2017 with the scope to modernize, expand (in case of existing pipelines) or construct (in case of new projects) Russian pipelines.

Potentially, the sanctions can target any existing and new pipeline originating from Russia, and which transports hydrocarbons across an international land or maritime border for delivery to another country. Conversely, as the guidance indicates, pipelines that originate outside Russia and transit its territory, or pipelines that originate in Russia but cross only the country’s territory and not an international border as well would not be targeted by CAATSA sanctions.

The conjunction reading of CAATSA’s provisions and above-mentioned guidance leads to the unambiguous understanding of the following aspect pertaining to the implementation of sanctions: the imposition of sanctions will be a matter of coordination between the Secretary of State and Secretary of the Treasury on one hand, and the allies of the United States, on the other. As the European countries are deemed to be considered U.S. allies, one can presume that the United States would discuss and negotiate the sanctions with its European partners and any compromise in this regard would aim, as the guidance states, “to avoid harming the energy security” of the latter.

In addition to the above mentioned understanding, the Department of State guidance contains several key-elements that do not leave too much wiggle room to interpretation when the following question arises: can Nord Stream 2-and subsequently TurkStream- be spared from sanctions? The first element is made up by two items: i) the reference to energy security of U.S. partners: “Any implementation of Section 232 sanctions would seek to avoid harming the energy security of our partners”, and ii) the reference to one of provisions of CAATSA, such as : “Consistent with the Act (Section 257), it remains the policy of the United States to “’work with European Union Member States and European institutions to promote energy security through developing diversified and liberalized energy markets that provide diversified sources, suppliers, and routes’”.

The Section 257 of the bill largely refers to Ukraine’s energy security and provides a detailed list of measures-from market liberalization to effective regulation and supply diversification- that the United States commits to implement in cooperation with the Ukrainian authorities. Moreover, the Section 257 plainly states that “it is the policy of the United States (…) to work with European Union member states and European Union institutions to promote energy security through developing diversified and liberalized energy markets that provide diversified sources, suppliers, and routes” and “to continue to oppose” the Nord Stream 2 pipeline project.

Consequently, an interpretation based solely on the references to energy security of European Union and Ukraine does not suffice to provide a comprehensive answer to our question as the assessment needs to be done in conjunction with other three relevant elements. One of these elements is the wording “in coordination with the allies”, which is included both in the text of CAATSA (Section 232) and State Department’s guidance. The language “in cooperation with allies” was one of the changes made by the House of Representatives, “in response to European lobbying”, and specifically to Germany’s demand, to the initial bill of Senate.

The Nord Stream 2, whereas originates in Russia, it aims to transport natural gas across a maritime border but it will transit through the Russian territory: its starting point is in Kingiseppsky district of the Leningrad region, from where it will cross the Narva Bay and the Kurgalsky peninsula; the pipeline’s onshore part is about 3.7 km long and the offshore part is about 114 km long within the territorial waters of Russia. In this regard, it is worthy of mention that, according to the United Nations Convention on the Law of the Sea (UNCLOS), the sovereignty of a coastal state extends to its territorial sea, to the air space over the territorial sea as well as to its bed and subsoil. Put it differently, the Nord Stream 2 pipeline will cross a territory under the sovereignty of the Russian Federation, and this element potentially excludes the project from sanctions implementation.

Also, the main investments and loan agreements pertaining to Nord Stream 2 had been signed prior to August 2, 2017, which represents another significant rationale to consider when assessing that the pipeline project would likely not be affected by CAATSA’s sanctions. For instance, Nord Stream AG signed the contract for offshore pipelay through the Baltic Sea with Allseas company on April 6, 2017, whereas the contract for weight coating, storage and logistics of the 200,000 pipes required for the project was granted to Wasco Coatings Europe BV on June 21, 2017. Furthermore, the most important agreement, pertaining to the pipeline project’s funding, was signed by Nord Stream 2 AG with ENGIE, OMV, Shell, Uniper and Wintershall on April 24, 2017.

The official information on Turkish Stream does not provide clear elements on pipeline’s route hence the assessment is based rather on inference and not on explicit facts. The pipeline’s case appears to be different from Nord Stream 2’s because the former starts on the Russian coast, near Anapa, and seemingly does not run into the Russian territorial waters but into Russia’s Exclusive Economic Zone (EEZ). The legal situation of EEZ is more complex than that of territorial waters as the EEZ is “beyond and adjacent to the territorial sea”, and not part of a state’s national territory.

Furthermore, according to UNCLOS, the coastal states have “sovereign rights” over the EEZs, for the purpose, inter alia, of economic exploitation and exploration of the zone. Nonetheless, as Gazprom and Allseas signed the contract for the pipeline’s first string on December 8, 2016, and contract for second string on February 20, 2017, the main investments in this project fall outside of sanctions’ scope.

4. Conclusion

The U.S. sanctions against Russia fall into the category of smart sanctions whose purposes are constraint and signalling. Until the adoption of CAATSA, the United States closely coordinated the sanctions regime on Russia with the European Union. If implemented alone, the measures would have had a negligible effect, given that the United States had had a low level of trade and direct investment with Russia before sanctions’ implementation.

Generally, Germany’s approach to the sanctions, which sought to limit their impact on the oil and gas sectors, and specifically its tough opposition to CAATSA’s sanctions on pipelines can be explain by the sensitivity interdependence between Berlin and Moscow in the energy sphere. The EU’s and, in particular, Germany’s reaction to CAATSA have deterred the unilateral imposition, from the United States sanctions, of the sanctions.

The introduction in the bill, by the House of Representatives (and in response to the European lobbying) of the language “in cooperation with allies”, in conjunction with the guidance issued by the State Department are elements indicating that, despite the American officials’ public positions against Nord Stream 2, the United States would likely not apply CAATSA’s sanctions on pipelines in a way that would sow the trans-Atlantic divisions.

Nor CAATSA sanctions would be applied in a way that would harm the interests of the companies involved in the project, specifically of the German ones. Potentially, preserving Germany’s, respectively EU’s cooperation on all the other sanctions against Russia is the main rationale for which the sanctions implementation was designed in a benign way towards pipeline projects like Nord Stream 2.

The Trump administration had faced a deadline on January 29 to impose secondary sanctions on anyone-person or entity- determined to conduct significant business with Russian defence and intelligence sectors but it delayed their imposition, arguing that the January date is not a deadline and sanctions will be imposed in the near future. Unlike the sanctions on defence and intelligence sectors, the sanctions comprised in Section 232 are arbitrary, not mandatory. And one can assume that if the current American administration has not yet carried out CAATSA’s mandatory sanctions, it would not rush to implement the bill’s arbitrary sanctions.